Tuesday, September 27, 2011

Roger Lowenstein had an interesting article in the NY Times Magazine this past Sunday, concerning the fuzzy line between legitimate information gathering and felonious “insider trading” [http://www.nytimes.com/2011/09/25/magazine/in-the-insider-trading-war-market-beaters-beware.html?_r=1&ref=magazine].His point was that what counts as insider trading is not clear, and that this is a virtue, not a drawback, to the regulations. If regulations were clear and unambiguous, then traders would quickly find a sure path on which to avoid them.

The article brought to mind the disclosure several months ago that David L. Sokol, protégé of Warren Buffett, purchased shares in a company shortly before Buffett’s Berkshire Hathaway bought it.Buffet’s announced investment caused shares of the company—Lubrizol—to skyrocket, and Sokol stood to make millions.What made this case so striking was Buffett’s pristine repution.

Was Sokol’s purchase of Lubrizol an instance of insider trading?And was Buffett complicit in that Sokol had informed him of the position in Lubrizol while the purchase was being contemplated.Both men assured us that Sokol did nothing illegal.U.S. securities laws require disclosure of “material information,” which has in turn been defined by the Supreme Court as information where there is “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as

having significantly altered the ‘total mix’ of information made available.”This definition, as Lowenstein points out, leaves plenty of room for interpretation.Moreover, the fact that Sokol did not have final decision authority in making the deal almost certainly mitigates against a ruling of materiality.So we were willing to bet that Sokol did nothing “illegal.”

But is what he did unethical?Here, too, the situation was far from straightforward.He might have advised Buffett to do the deal for the same reason he bought the stock—because he thought that Lubrizol was a good and undervalued company.Buffett has made his billions precisely by seeking and then buying good, but undervalued companies.I doubt that if you put a bunch of business ethics professors together in a room they would emerge with a consensus about whether Sokol and Buffett did anything unethical.Admittedly it seems odd that a man like Buffett, who apparently values his reputation for honesty and integrity more than all his billions, would do anything that had even the appearance of impropriety.But the issues are complicated, and reasonable people can disagree, so perhaps we should the “Wizard of Omaha” deserves the benefit of the doubt.

What this episode reveals, beyond its particulars, is how difficult ethical judgments can be in the complex world of finance.Sure, we can make a bunch of “bright-line rules,” but as long as the world the rules apply to is fuzzy, there will always be room for interpretation and disagreement.

So, to cut through this complexity, I want to propose a single, simple ethical rule of thumb—one question people should ask themselves before embarking on a course of action.If people asked themselves this question, and took the answer to heart, we wouldn’t need ethics courses, ethics texts, and ethics panels.The question is this: “Would you tell your children?”If the answer to that question is yes, then go ahead and do it.If not, back away.

Other quick and dirty rules of thumb have been proposed over the years, but this one has the others beat.“Does it pass the smell test?” is one, but we invented perfume so that almost anything can pass the smell test.“Will you be able to look at yourself in the mirror?” is another, but for forty years psychologists have documented the ways in which people can deceive themselves when they look in the ethical mirror.“Would you tell your spouse?”That’s better, but also flawed.Our spouses have already learned about our various moral imperfections.They’ve gotten used to us.And they’ve learned from experience how ethically ambiguous life can be.We’re afraid that our spouses are too likely to give us a pass, or at least, the benefit of the doubt.But our kids?To kids, the world is a place of moral clarity and moral perfection, and their parents are moral heroes.There is no money in the world that can make up for the look of disappointment in a child’s eyes.If people just got in the habit of asking themselves this one question, many of the ethical problems we encounter on a daily basis would vanish.

Would a doctor order a procedure she thought unnecessary to earn a fee because she knew it would do no harm?Not if she asked herself this question first.

Would a banker offer a no-doc, unaffordable loan to eager home buyers, even if the post-teaser rates were fully disclosed and the clients insisted they knew what they were getting into?Not if he asked this question first.

Would a teacher deliberately teach students items that would be on the standardized test, even when he thought it was bad pedagogy?Not if he asked this question first.

And would Sokol and Buffett have done the deal?We don’t know the answer to this one, but my guess is that at the very least, they would have thought longer and harder about it before going forward.It’s amazing how ethically complex issues get simplified when we imagine having to explain ourselves to our kids.

We know that not everyone has kids, that some people’s kids are too young, and other people’s kids are too old—already jaded by corrosive experience in the actual world.But it shouldn’t be hard to adapt this question to your individual circumstances.“Would I tell my sister’s kids?”“Will I tell my kids when they get a little older?”“Would I have told my kids when they were in sixth grade?”I’m convinced that if we adopted this family of questions as our ethical touchstone, we could throw most of the ethics texts, casebooks, and guidelines away.We would do the right thing more often, and with less effort.

Saturday, September 17, 2011

Each week, the NCAA college football rankings come out, and they attract much interest on the part of college football partisans.Since 1936, these rankings have been assembled by the Associated Press, and for many years, they were the only way to judge who was better than whom.Then, with the advent of the Bowl Championship Series, the rankings stakes escalated, and a complex computer-assessed algorithm joined the opinions of sportswriters.

The squabbling about the rankings, whatever their source, is unending.No doubt, it’s part of the fun of college football season.Different people have different views about what should go into the assessment, and how much weight each factor should get.In a sense, however, there is a reasonable empirical test of the accuracy of the rankings.When ranked teams play, the higher ranked team should defeat the lower ranked team.Rankings are, after all, just predictions about who will win when ranked teams go at it.I looked at the results of games played between the number 1 and number 2 ranked teams over the 75 years that ranking has been done.Number 1 has played Number 2 41 times, and Number 1 has been victorious in 24 of those games.Better than 50%, but not a lot better than 50%.So ranking is hard.There is error in measurement, and there is error in the weights assigned to different things being measured.Almost certainly, when teams ranked closely together are compared, the error in measurement and weighting exceeds the difference in quality between the teams.Error could be reduced if, say, we just presented a list of the 20 best teams, in no particular order, without identifying any of them as Number 1.But that would be much less fun.

I don’t really care about college football—a game played by pros disguised as students, overseen by coaches and administrators who are almost completely corrupt.What I do care about—a great deal—is rankings of the quality of colleges, universities, and professional schools.If ranking football teams is hard, ranking school quality is impossible.Not only are there many more factors to consider, but the criteria are totally ambiguous.No one is suggesting that if Williams College is the number 1 liberal arts college, and Swarthmore is number 2, that Williams would “beat” Swarthmore if they played.Played what?It is, in short, a fool’s errand to rank colleges and universities.Rankings convey a false precision that is extremely misleading.Yet, the rankings go on, and U.S. News and World Report coins money by publishing them, and high school kids and their parents are driven by the rankings in deciding where to apply and where to go, while the schools themselves strategize to try to move up the ladder (“Don’t admit that spectacular student.She’s too good.We’re just a safety school.She’ll never come, and that will make our ‘yield’ look bad in the U.S. News rankings.”“Let’s try to get every alum to give us something—even five dollars.That way, our alumni participation will look good in the U.S. News rankings.”)I wish I were making this up, but I’m not.

If college rankings were harmless, however inaccurate, we could let schools have their fun, U.S. News make its money, and just ignore the foolish enterprise.But unlike the rankings of college football teams, they aren’t harmless.They lead students to ask “what’s the best school?”—the wrong question, rather than “what’s the best school for me?”—the right question.Much time, money, and angst are wasted in pursuit of a non-existent objective.This nonsense really must stop.

What would a sensible alternative be?Well, one alternative that would reduce the damage is for the rankers to identify the twenty top, next-to-top, and so on, schools in each category, and then present them, unordered.This would not eliminate foolishness.The schools ranked 21-25 would struggle to game the system so that they made it into the top tier, and the schools ranked 16-20 would game the system to maintain their position against competition.But it would certainly reduce the game playing.And it would eliminate the false claims to precision that such rankings imply.Is there any chance that U.S. News would do this on its own?Not a chance.Sales would suffer.The buzz surrounding the annual ratings issue would die down.Then is there any chance that U.S. News could be pressured into adopting this more sensible approach?Maybe.

What if the “elite” in every category banded together and refused to cooperate unless and until U.S. News mends its ways.You can’t stop the magazine from producing the rankings, but the rankings might quickly lose credibility if the numbers on which they were based were known to be unreliable.Is there any chance that the elite might band together in this way? Well, getting them to cooperate won’t be easy, and here’s why.There is almost certainly a relation between the rankings of the schools and their quality.It’s just that the direction of causality is opposite to what you, and U.S. News imagine.What really makes one school better than another is the quality of the students who attend.Rank almost any good school number 1, and it will become number 1, because it will attract the best students, who then teach one another.In other words, rankings differences cause quality differences rather than reporting them. It is worth noting that economist John Maynard Keynes made this point years ago, in discussing the picking of stocks.What matters, he said, is not what’s the best company.What matters is what you think other people will think is the best company.That’s what will drive the share price up, and that’s the bandwagon you want to be on.In other words, thinking Acme Widgets is the best company is what makes it the best company, at least for investment.Similarly, thinking that Swarthmore is the best college is what makes it the best college—because the best students will go there.

But if Williams, Amherst, Swarthmore, Pomona, and Wesleyan band together and stop cooperating, and the rankings as we know them go away, the quality of the students they attract will go down, as high school seniors distribute themselves to other institutions. Similarly, if Yale, Harvard, Princeton, and Stanford stop cooperating.And unless the top schools stop cooperating, nothing will change.If a school ranked number 12 doesn’t play the game, it will be interpreted as nothing but sour grapes.

So what can possibly induce the elite to use what leverage they have to get U.S. News to change its practices?Why would any institution act against what seem to be its own best interests?Why would any school do anything that might reduce the overall quality of its student body? My answer, stimulated more by hope than by experience, is that elite schools might do it just because it’s right.It’s right because colleges and universities are our bastions of truth-seeking, and as defenders of truth, they should not participate in anything that seriously distorts truth.And it’s right because they are interested in doing whatever they can to help students make wise decisions, and rankings are to a large extent the enemies of wise decisions.So what I would love to see is movements by faculty and students on campuses across the land to convince their administrations to say “enough!”If administrators can’t be persuaded to do the right thing, perhaps they can be shamed into it.

Monday, September 12, 2011

Today’s New York Times has an article reporting that financial markets are much more volatile these days than they have been historically [http://www.nytimes.com/2011/09/12/business/economy/stock-markets-sharp-swings-grow-more-frequent.html?_r=1&hp]. Three percent or greater swings in market indices—both within a trading day and between days—used to be rare, but now are commonplace. The facts are clear, but the cause is not. The article discusses several possibilities, all of them internal to the current world economic situation and/or the velocity with which trading occurs in our computerized age. There may be truth to some or all of the possibilities, but I want to suggest another possible causal factor that has nothing to do with market fundamentals, economic events, or trading practices. I want to implicate the media.

I get almost all my news from NPR, the Times, or the PBS Newshour. These sources are all models of probity; they all wear sensible shoes. Nonetheless, what I hear and read virtually every day from these sources are locutions like “financial markets soared (or plummeted) on, or after, or with, reports that Greece is closer to default, or Bank of America’s earnings were below expectations, or high-tech sector sales are down, or [fill in the blanks.] I want you to focus on those three little words—“on,” “ after,” and “with.” None of those words says outright that the financial news event in question caused the market rise or fall. Financial reporters are much too savvy to make clear causal statements outright. But each of these words implies causality. They imply a connection between the financial event and the market’s behavior. If not, why would you even use those words. You would report on hi-tech sales, and you would report on market behavior, just as you might report on the September 11 anniversary observances and the winner of the women’s singles at the U.S. Open Tennis Championship.

It is a part of virtually every introductory psychology course to make the point that “correlation does not imply causation,” and you might think that this somewhat careless financial reporting is merely an example of the commonly-made correlation/causation mistake. Sadly, it’s even worse than that. What we might say here is that “coincidence does not imply correlation.” With a single event in the antecedent category (eg., low earnings for Bank of America) and a single event in the consequent category (market prices), no correlation can meaningfully be computed. One-time events do not “correlate” with anything. At the very least, reporters or analysts would have to put these antecedents into classes or categories, so that they might be able to say something like “past reports of low earnings from financial institutions have been associated with drops in the market.” Obviously, reporters never do that. But even if they did, the placing of isolated events into classes is by no means uncontroversial. Can we really treat a low earnings report in 2011 as equivalent to a low earnings report in 1975? Doesn’t context matter? And what industry from the 1960’s is analogous to the hi-tech industry today?

So, assuming that we can agree that even the most respectable news sources can be sloppy, what does that have to do with increased volatility? Here’s my speculation. When we hear, again and again, that the market dropped on, after, or with some financial event, we “learn” two things—both of which may be false. The first thing we learn is that financial events of that type cause changes in the market. The second thing we learn is that a causal analysis of market behavior is actually possible. Now, when we read about significant financial events, we feel compelled to act on them, because of the implied causal role they play in market behavior. And since everyone hears the same news, you get herds of investors acting on the news and the causal relation that it implies. The financial events themselves may not be causal (a model of market behavior that remains plausible decades after it was first proposed treats the behavior of stocks as largely random), but news reports of those events may be causal.

More than three-quarters of a century ago, noted economist John Maynard Keynes famously wrote of “animal spirits” (read “psychology”) and the enormous effect they had on the economy. About this, as much else, Keynes was surely correct. But he did not have much to say about what fed the animals. And I’m proposing that one significant source of animal nourishment is thinly disguised, but completely unjustified, causal implications that have become a part of our daily diet of financial news.

What can we do about this? As individuals, I suppose we can vow not to act on “with,” “after,” and “on.” But (a) as individuals we will affect little, and (b) worse yet, if everyone else is acting on them, we may take a financial bath. More likely to be helpful is if we campaign vigorously to stop this carelessness. Every time you see an “after” in a Times story, write a letter to the editor. Every time you hear an “after” on NPR, send an email. Maybe, eventually, they’ll get the message. There probably isn’t much we can do to stop Jim Kramer’s hysterical rants about what the financial future holds, but we may be able to stop the very influential feeders or our animal spirits from continuing the feast. They need to help us go on a news diet.

Tuesday, September 6, 2011

What with Labor Day just behind us, and unemployment at 9%, it seems appropriate to write about work, and especially good work. In a Times op-ed on Sunday, Teresa Amabile and Steven Kramer wrote about what makes work good, and also about how good work makes for happier and more productive workers [http://www.nytimes.com/2011/09/04/opinion/sunday/do-happier-people-work-harder.html?_r=1&partner=rss&emc=rss]. They show that our drive for increased efficiency, and tighter managerial control, is not only misguided, but counterproductive.

This brings me to Steve Jobs. In the aftermath of Steve Jobs’ resignation as CEO of Apple, much has been written about what makes Jobs unique and what has made Apple the most valuable company on earth.Jobs is a creative genius, coming up with products that no one could have imagined.Jobs is an intuitive genius, knowing what people want before they do. Jobs is a design genius, coming up with products that look and feel as great as they operate. Jobs is a marketing genius, able to get people to want things that they don’t need.Jobs is a perfectionist who demands only the best and does not suffer fools.

I don’t doubt that each of these characterizations is true, but I think they miss what is most essential about Jobs, and what separates people who are outstanding from those who are merely competent throughout society.To put it succinctly, for Steve Jobs, it’s not about the money.His aim, in creating the first Apple computers with Steve Wozniak, was to produce devices that were powerful, reliable, and easy to use—devices that would move computing from the office to the living room.Get the device right, and the money will take care of itself.The same seems to me to be true of the Macintosh, the iPod, the iPhone, and the iPad.Get the device right, and the money will take care of itself.Indeed, the same was true of Pixar.When Jobs owned that animation studio, the aim was to make great movies, no matter what the cost.And make great movies they did, and have continued to do, making piles of money along the way.

Early in Apple’s history, its computers were regarded disdainfully as toys.As someone who has used Apple computers from the beginning, let me assure you that they were anything but toys.They may have looked like toys, and they may have been easy and fun to use like toys, but they were very powerful indeed, and amazingly reliable.The only limit on what they could do was the availability of software.And this, for years, was a significant limit, because the folks wearing stodgy gray suits in businesses thought they needed to have stodgy computers to match.

I don’t mean to suggest that Apple in general, and Jobs in particular, were completely indifferent to bottom lines.Apple has shareholders, and shareholders have to be satisfied.It’s just that they never seemed to let the business model get in the way of the product model.They understood that the aim—the telos—of the organization was to make amazing things, and that financial success would come as a by-product of achieving that aim.

I don’t think that Jobs and Apple were at all unique in this regard.I believe that Bill Gates and Paul Allen had the same aspirations when they began Microsoft.I believe that William Hewlett and David Packard had the same aspirations when they began Hewlett Packard.I believe that Sergey Brin and Larry Page had the same aspirations when they began Google.And I believe Mark Zuckerberg had the same aspirations for Facebook.What may distinguish Apple from these other enterprises is that it never seems to have lost sight of the main point.Neither, near as I can tell, did Hewlett Packard, at least until the shadow cast by its founders began to fade.Microsoft arguably has, a victim, in part, of its extraordinary success but also a victim of a lost vision of what it was founded to do.With Google, the jury is still out, though I think it is telling that when Brin and Page set up their IPO, they did it in their own way, to keep the bean counters from gaining control of the company.It’s just that when the stakes get high enough, the pressure to deviate from your telos in the service of a business plan gets awfully hard to resist.

We deeply respect and admire people who are not “in it for the money.”Even when such people accumulate a lot of it.And not just in business.Part of why Derek Jeter and Mariano Rivera are such heroes to New Yorkers is that they kept their exploits as appropriate fodder for the sports pages rather than the business pages (though the Yankees managed, crassly, to sully Jeter just a little bit this past off season).They both want to do what they do as well as it can be done.The money will take care of itself.That’s why we admire first responders, and dedicated teachers and physicians.When we know that people are not doing their jobs for the money, we don’t begrudge them their sometimes outsized rewards.Even Goldman Sachs, the evil empire, was, until it went public, committed to serving clients and not (just) to serving itself.The bankers at Goldman Sachs are, like Steve Jobs, both smart and creative (the investment instruments they and their fellow investment banks conjured up were nothing if not creative).What led the investment banks astray was that they lost sight of their telos.And in going astray, they took many of the rest of us down with them.

And yet, despite our admiration for people who are not in it for the money, we keep thinking and acting as if the way to improve education, healthcare, finance, and pretty much everything else is to get the incentives right.We don’t admire people who are in it for the money, and yet we try to fix our social institutions by acting as if we do.

It isn’t too late to wake up, to celebrate people who want to do the right thing because it’s the right thing, and to make it easier for them to do so.A personal hero of mine, Bruce Springsteen, said it best in an interview he gave to Rolling Stone almost 20 years ago:

I understand that it’s the music that keeps me alive…That’s my lifeblood.And to give that up for, like, the TV, the cars, the houses—that’s not the American dream.That’s the booby prize, in the end.

If we remember that, and we celebrate Steve Jobs for the right reasons, perhaps we can create a society that makes it easier for others to follow in his wake.

Saturday, September 3, 2011

A new season of college football is upon us, and as we delight in the thrilling plays, the superhuman feats of athleticism, the inspiring pageantry, and the heart-warming school spirit, out of the corner of our eye we’ll be watching for the next recruiting scandal, the next illicit payoff, the next tale of vanishingly small graduation rates, and the next shift of teams to new conferences.It happens every year.Just when we think we’ve seen the worst, participants in this fall drama surprise us.Coaches earn many times what college presidents do, “amateur” athletes auction themselves off to the highest bidder, and universities find ways to keep athletes eligible with silly courses that can’t be failed.Every year, the National Collegiate Athletic Association (NCAA), charged with regulating college sports and policing the regulations, promulgates more rules and threatens more draconian penalties for violations.Athletes lose eligibility.Teams forfeit games. And sometimes—rarely—schools get the “death penalty”—a loss of scholarships, disqualification from future bowl games, and even suspension of the program all together. Yet every year, schools either find ways to skirt the rules, or just violate them.And every few years, a new NCAA commissioner, drawn from the ranks of respected academics, promises to get tough and fix things.

It has reached a point, I think, where most fans have given up.Some have just stopped following the sport.Some have buried their heads in the sand and avoided coverage of the scandals in the news.And some have urged that we abandon the “amateur” charade, and just start paying athletes as the professionals they really are.

As someone who has spent a long career teaching at an institution in which athletic scandals are not a problem, I am nonetheless deeply shamed by practices that cast doubt on the integrity of all academic institutions.Is there really no way to fix the problem?

Actually, I think we can fix it.We can exploit an invaluable lesson taught more than half a century ago by Kurt Lewin, one of the founding fathers of social psychology.Lewin observed that motivation is often a portrait of people in conflict.Some forces push toward action; others push toward inaction.Or some forces push toward one action, whereas other forces push toward a different action.Lewin further observed that most of the time, when we want someone to do X, we try to make the forces that encourage X stronger.To get our kids to study hard, we offer rewards for good grades or threaten punishments for bad ones.But, Lewin argued, it may often be easier to identify the forces that are impeding the behavior we want, and weaken them.If countervailing forces are weakened sufficiently, little needs to be done to get the behavior we want.

So, in the case of college athletics, the NCAA has laid one carrot and stick on the table after another to get institutions to follow the rules.And nothing has worked.Let us ask, instead, what are the forces that are interfering with ethical conduct in college athletics, and what can be done to weaken them.

Well, the 800-pound gorilla is money.Leaving aside the revenue from ticket sales, souvenirs, and concessions that the University of Michigan, or Ohio State, or Penn State, or the University of Texas take in whenever they play before 100,000 fans at their home stadiums, there are literally billions of dollars on the table from television.And millions more from participating in end-of-the-season bowl games. Is there anything to be done to weaken the financial incentives that are blocking schools from doing the right thing?Can we take some of the money away?

Some have suggested that revenues from football (and men’s basketball, the other big-money sport) go into the general operating budget of universities and not back to athletic departments. That way, the incentive to break the rules will be weaker.But a move like this is just self-deception.We all know how fungible budget categories are. If football money goes for, say, scholarships, then what used to be scholarship money will go for football.

No, a more radical solution is needed.What if all the revenue produced by college sports was put into one big pot, and then divided among all colleges and universities pro rata, based on how many students attend.Then, Ohio State would be playing to enrich Ohio State, but not only Ohio State.Some of its money would go to Harvard, some to the University of Washington, some to Gallaudet, some to Wesleyan, and some to Swarthmore.All schools would welcome the revenue, and could use it in whatever ways most enhanced their academic programs.Sure, more money would still be better than less, but there would be much less reason to cheat with the financial rewards for cheating diluted in this way.There would also be less money available to provide outsized contracts to coaches.

We can’t stop TV networks from throwing money at colleges, but we can stop the colleges from catching it.And if we do—if we remove the temptation that challenges honesty and integrity, people’s desire to be able to look at themselves in the mirror each morning might take control.

Come to think of it, this might be a good way to reform financial institutions.I have no doubt that the Dodd-Frank regulation of financial institutions will have salutary effects—for a while.But if history is any guide, it won’t be long before these institutions find ways around these new regulations.The problem, as with college sports, is too much money washing around in the system.But we could take some of it away.We could impose a healthy tax on short-term financial transactions (the so-called Tobin tax).We could tax hedge fund profits as ordinary income rather than as capital gains.Indeed, we could tax capital gains as ordinary income.If we make the rewards for irresponsible, if not illegal, speculation less plentiful, we may remove the countervailing force that prevents people from doing the right thing.And from what I read, the U.S. Treasury, like our colleges and universities, could certainly use the money.

Instead of continuing to believe, in the face of years and years of disconfirming evidence, that the right combination of rules and incentives is the way to get either our college football teams, or our banks, to do the right thing, we might just try taking a page from Kurt Lewin and instead take away the obstacles that are preventing them from doing the right thing.It’s certainly worth a try.

Thursday, September 1, 2011

After a very long string of rejections from the New York Times and other traditional media outlets, I've decided to do it another way. My plan is to write something every few days that comments on something or other going on in the world. My perspective comes from forty years of reading, research, and teaching as a psychologist, much of that spent pondering the relation between psychology and economics. I hope to stimulate readers to think a little differently about the things I cover, and perhaps to start talking to others. My view is that modern America operates with a kind of "received wisdom" that is both untrue and unwise, and we need to start kicking ourselves, and others, to think about what we do differently.

So let me begin with a pet idea: The United States needs a Council of Psychological Advisors. This new body would parallel and complement the Council of Economic Advisors. When economists have the president’s ear, all their whispers concern incentives and self-interest. We need psychologists whispering in his other ear, about the economy, education, healthcare, and more.

On the Economy: Understand the “Irrational.” Where did our financial institutions go wrong? Many accounts focus on greed, fear, and lack of trust. And why did things get so out of hand? Why was there a housing “bubble”? Somehow, “irrational exuberance” (Robert Schiller) or “animal spirits” (John Maynard Keynes) overwhelmed rational calculations of risk and reward. And it isn’t just that irrational optimism, or even blindness to market fundamentals, gets the better of our rational faculties. Rather, as George Soros has pointed out, these psychological phenomena can become part of a feedback loop that actually changes market fundamentals. “Reflexivity,” he calls it. The housing bubble was not the first such phenomenon, nor will it be the last.

Economists offer little that helps us understand why such bubbles occur or how they might be prevented. They also have little to tell us about how to prevent a “downward spiral of negative expectations” that makes fear of an economic downturn self-fulfilling. Economists largely make assumptions about the rationality of human decision-making and proceed from there. Witness Alan Greenspan’s admission after he stepped down as chairman of the Fed that he was mistaken in assuming that markets operate rationally and efficiently. The current crisis makes it clear that ignoring the real psychology of greed, fear, trust, and irrational enthusiasm (or pessimism) can be perilous. Economists offer little that helps us understand why such bubbles occur or how they might be prevented. A Council of Psychological Advisors could help.

On Education: More than Just Carrots and Sticks.One of President Obama’s top priorities is to improve the quality of American education. This will require recruiting and retaining excellent teachers and finding ways to motivate students. How can this worthy goal be achieved? At the moment, we’re pointing in the direction of school choice and competition to produce better schools, higher pay to produce better teachers, big tests to monitor performance, and financial incentives to motivate students. A bunch of carrots and sticks.Will these kinds of measures be enough? Research in psychology suggests not. More important than pay (as long as it is adequate) are working conditions that allow teachers to be flexible, autonomous, and creative in their work with students, and that provide teachers with a sense that they are working in a community that has a common purpose. From this perspective, the regimentation of instruction ushered in by big-test accountability is actually counterproductive. And so is the move, now being tried in pilot projects around the country, to pay students for showing up to class and for getting good grades. A Council of Psychological Advisors could help design environments that encourage students to pursue mastery rather than money and teachers to view their work as a calling.

On Health Care: Understanding Efficacy and Managing Chronic Conditions.Everyone should have health insurance. This is necessary, but not sufficient. The cost of health care must come down. Computerized medical records that produce coordination of care will help bring down costs, but it also isn’t sufficient. We need to help patients (and their doctors) understand how to think about the efficacy and the risks involved in various medical procedures, so that fewer unnecessary, but costly procedures are undertaken. There is plentiful evidence that patients make serious mistakes in thinking about risks and efficacy, and that their doctors make the very same mistakes! Moreover, most medical care in a developed country like the U.S. involves management of chronic diseases (hypertension, heart disease, diabetes, asthma). Managing these conditions effectively demands that patients be partners; they need to make lifestyle changes (eg., diet, smoking, and exercise) that are often difficult to adhere to. A Council of Psychological Advisors can help in designing formats for presenting evidence about the efficacy and risks of various treatments that will reduce misunderstanding and thus reduce unnecessary procedures. And it can help develop interventions that will make patients healthcare partners more effectively.

On the Environment: Do It Because It’s RightTraditional economic incentives like investment tax credits, energy taxes, and pollution credits might help us reduce our environmental footprint, but focusing exclusively on these neglects the extraordinary opportunity to call on citizens to do the right thing because it’s the right thing. Indeed, there is even evidence that incentives can undermine people’s desire to do the right thing. In a Swiss study of citizen-willingness to have a nuclear waste dump located in their communities, researchers found that whereas 50% of citizens agreed (reluctantly) when no incentives were involved, only 25% agreed when substantial incentives were involved. Each of us can take responsibility as citizens to contribute in small ways to solving the big environmental problems we face. A Council of Psychological Advisors can help in crafting appeals to citizens to do their duty.

Moving Beyond GDP.Finally, let us ask the most fundamental question: what is public policy for? We aim to increase collective welfare, but just what does welfare consist in? For the most part, under the sway of economic thinking, our aim has been to make the country more prosperous—to increase per capita GDP. The appeal of this goal is two-fold. First, we assume that if people are richer, they will be freer to choose as individuals the objects and activities that serve their welfare. We (the state and its technocrats) don’t have to choose for them. So wealth serves as a proxy for everything else. And second, GDP can be measured. But like a drunk looking under a lamp post for his car keys, even though he dropped them someplace else (because “that’s where the light is”), it doesn’t help much to pursue what you can measure if what you’re measuring is the wrong thing. It doesn’t help to get better at achieving goals if you’re achieving the wrong goals. Much research in the psychology of well being suggests that some wealth-enhancing policies improve welfare, but others do not. Indeed, some of what it takes to get more prosperous may be counterproductive when it comes to well being. A Council of Psychological Advisors can help here too, in the design of a system of national “psychological accounts” that does a better job of measuring well being than per capita GDP ever could.

Many of us held out the hope that the Obama administration would mark a return to respect for knowledge and expertise. Agencies would be run and staffed not by political cronies, or by people who “just know in their gut” what needs to be done, or by ideologues, but by people who actually have respect for evidence. It would be a shame to bring experts on board in existing agencies, only to have them have to rely on personal intuition rather than knowledge in formulating policies and making decisions that could benefit from psychological expertise. I think President Obama did indeed have exactly this inclination, but to a large degree, politics has gotten in the way. But one can still hope. A Council of Psychological Advisors is long overdue. This would be an excellent time to create one.